First-Half Global Liquidity Watch

By: Doug Noland | Fri, Jun 29, 2007
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A volatile second quarter ended with heightened volatility and nervousness. For the week, the Dow gained 0.4% (up 7.6% y-t-d), and the S&P500 added 0.1% (up 6.0%). The Utilities rallied 2.0% (up 6.2%), while the Transports dipped 0.2% (up 11.8%). The Morgan Stanley Cyclical index fell 0.6% (up 20.5%), while the Morgan Stanley Consumer index gained 0.4% (4.8%). The broader market was little changed. The small cap Russell 2000 (up 5.8%) and the S&P400 Mid-cap (up 11.3%) indices both slipped 0.1%. Technology stocks continue to outperform. For the week, the NASDAQ100 gained 0.6% (up 10.1%), while the Morgan Stanley High Tech index was little changed (up 9.6%). The Semiconductors lost 0.7% (up 7.1%). The Street.com Internet index rose 1.5%, increasing y-t-d gains to 10.0%. The NASDAQ Telecommunications index surged 2.9%, increasing 2007 gains to 11.0%. Financial stocks were out of favor. The Broker/Dealers dropped 1.6% (up 4.1%), and the Banks fell 0.6% (down 3.9%). With bullion down $4.85, the HUI Gold index declined 2.0% (down 2.6%).

Some flight from Credit risk to Treasuries. Two-year U.S. government yields fell 4 bps to 4.87%. Five-year yields dropped 8 bps to 4.93%. Ten-year Treasury yields sank 10 bps to 5.03%. Long-bond yields ended the week down 12 bps to 5.13%. The 2yr/10yr spread ended the week sharply flatter at 16 bps. The implied yield on 3-month December '07 Eurodollars declined 0.5 bps to 5.285%. Benchmark Fannie Mae MBS yields declined 5 bps to 6.26%, this week significantly underperforming Treasuries. The spread on Fannie's 5% 2017 note widened 2 to 44, and the spread on Freddie's 5% 2017 note widened about 2 to 45. The 10-year dollar swap spread increased 1.8 to a notable 63.8. Corporate bond spreads widened meaningfully, with the spread on a junk index surging 25 bps to a near three-month high.

June 29 - Financial Times: "The retreat from risk in global credit markets gathered pace yesterday as investors demanded stricter terms for North American high-yield bond issues and a London hedge fund said it would wind down after suffering big losses on US subprime mortgages. Dollar General, a leading US retail chain, was forced to shelve its planned offering of $725m in 'payment-in-kind toggle' notes, an aggressive financing structure that allows borrowers to choose whether to pay investors back in cash or additional debt... The issuance of bonds and loans with few, if any covenants, has been one of the most controversial practices of the recent leveraged buy-out boom.

Separately, CanWest MediaWorks...cut its own high-yield offering from $650m to $400m. 'The balance between sellers of debt and buyers of debt is evening out,' said Eirik Winter, co-head of fixed income capital markets at Citi... Carlyle Group, the US private equity company, delayed at the last minute the flotation in Amsterdam of an investment fund dealing in residential mortgage-backed securities to cut the offer price because of volatility."

June 27 - Financial Times (Richard Beales): "Debt investors are reassessing the risks they are taking and how much they need to be paid for them in a decisive shift away from the borrower-friendly market that has persisted in recent months. 'Previously the attitude was 'tough luck, you have to take what we give you'," says Kingman Penniman of KDP Advisors, a high-yield consultancy. Now borrowers are finding it difficult to secure the more aggressive financing structures. In particular, investors are rebelling against some of the terms sought by private equity firms financing buyouts. Financing for US Foodservice, Thomson Learning and others have faced particular pressure on the most aggressive structures, including 'payment-in-kind' or Pik notes that allow borrowers to pay investors with more bonds rather than using up sometimes scarce cash."

June 25 - Financial Times (Richard Beales): "Bankers have started hawking $62bn in debt for Chrysler, the US carmaker that Cerberus, the private equity group, last month agreed to buy from DaimlerChrysler. Loans totalling $22bn will test the strength of the market, at a time when big leveraged buy-out financings are in the pipeline and investors are nervous amid rising long-term interest rates and fallout from the market for US subprime mortgage- related debt. 'Volatility is hitting leveraged loans hard, just as a procession of gigantic LBOs inch toward the market,' said analysts at Standard & Poor's... A syndicate of banks is showing the Chrysler deal to investors around the US this week, with the financing set to close in a few weeks."

Investment grade issuers included Goldman Sachs $1.8bn, MidAmerican Energy $650 million, and Equifax $250 million.

June 29 - Dow Jones (Daisy Maxey): "Junk-bond investors have lately had a case of the jitters, and so have investors in junk-bond mutual funds: Their shareholders withdrew more than $400 million in the week ended Wednesday, according to AMG..."

Junk issuers included Community Health $3.0bn, Dollar General $1.9bn, Varietal Distribution $675 million, Telcordia Technologies $555 million, Nevada Power $350 million, Sierra Pacific Power $325 million, Metals USA $300 million, Paetec Holding $300 million and NMH Holdings $175 million.

This week's convert issuers included Gannett $1.0bn, Tektronix $300 million, Boston Private Financial $288 million, GCI Commerce $125 million, and Parker Drilling $125 million.

International dollar bond issuers included La Caixa $2.8bn, Opti Canada $750 million, Suncor Energy $750 million, FMC Finance $500 million, Canwest Media $400 million, and Bemax Resources $175 million.

German 10-year bund yields dropped 8 bps to 4.57%, while the DAX equities index added 0.7% (up 21.4% y-t-d). Japanese 10-year "JGB" yields declined 2.5 bps to 1.87%. The Nikkei 225 slipped 0.3%, reducing y-t-d gains to 5.3%. Emerging markets were mixed. Brazil's benchmark dollar bond yields added 2 bps this week to 6.10%. Brazil's Bovespa equities index added 0.2%, increasing y-t-d gains to 22.3%. The Mexican Bolsa declined 1.6% (up 17.8% y-t-d). Mexico's 10-year $ yields declined 4 bps to 5.91%. Russia's RTS equities index was little changed (down 1.3% y-t-d). India's Sensex equities index rallied 1.3%, increasing 2007 gains to 6.3%. China's Shanghai Composite index sank 6.6% for the week (up 42.8% y-t-d and 129% over 52-weeks).

Freddie Mac posted 30-year fixed mortgage rates dipped 2 bps to 6.67% (down 11 bps y-o-y). Fifteen-year fixed rates fell 3 bps to 6.34% (up 9bps y-o-y). One-year adjustable rates dipped one basis point to 5.65% (down 17bps y-o-y). The Mortgage Bankers Association Purchase Applications Index dropped 4.9% this week. Purchase Applications were up 10% from one year ago, with dollar volume 16.4% higher. Refi applications declined 2.5% for the week, although dollar volume was up 31.4% from a year earlier. The average new Purchase mortgage increased to $238,100 (up 5.8% y-o-y), and the average ARM rose to $398,900 (up 16.7% y-o-y).

Bank Credit added $0.3bn (week of 6/20) to a record $8.588 TN. For the week, Securities Credit declined $11.5bn. Loans & Leases jumped $11.9bn to $6.281 TN. C&I loans surged $15.6bn, and Real Estate loans jumped $17.7bn. Consumer loans increased $3.1bn. Securities loans dropped $20.0bn, and Other loans declined $4.7bn. On the liability side, (previous M3) Large Time Deposits fell $9.6bn.

M2 (narrow) "money" jumped $20.8bn to $7.252 TN (week of 6/18). Narrow "money" has expanded $208bn y-t-d, or 6.2% annualized, and $442bn, or 6.5%, over the past year. For the week, Currency added $0.4bn, while Demand & Checkable Deposits dropped $24.6bn. Savings Deposits surged $42.1bn, while Small Denominated Deposits were unchanged. Retail Money Fund assets increased $2.9bn.

Total Money Market Fund Assets (from Invest. Co. Inst.) added $2.0bn last week to $2.536 TN. Money Fund Assets have increased $154bn y-t-d, a 13.0% rate, and $419bn over 52 weeks, or 19.8%.

Total Commercial Paper jumped $10.3bn last week to a record $2.142 TN, with a y-t-d gain of $158bn (17.0% annualized). CP has increased $357bn, or 20%, over the past 52 weeks.

Asset-backed Securities (ABS) issuance slowed to $10bn. Year-to-date total US ABS issuance of $361bn (tallied by JPMorgan) is running about 3% behind comparable 2006. At $177bn, y-t-d Home Equity ABS sales are about a third below last year's pace. Meanwhile, y-t-d US CDO issuance of $187 billion is running 18% ahead of record 2006 sales.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 6/27) rose $8.2bn to a record $1.975 TN. "Custody holdings" were up $223bn y-t-d (25.5% annualized) and $337bn during the past year, or 20.6%. Federal Reserve Credit last week declined $4.7bn to $847.6bn. Fed Credit has contracted $4.6bn y-t-d, with one-year growth of $22.9bn (2.8%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $625bn y-t-d (26% annualized) and $937bn y-o-y (20.8%) to a record $5.436 TN.

June 29 - Bloomberg (Sam Nagarajan): "India's foreign-exchange reserves increased $1.53 billion to $212.55 billion in the week ended June 22..."

Currency Watch:

The dollar index fell 0.5% to 81.69. On the upside, the Romanian leu increased 2.3%, South Africa's rand 1.6%, the Thai baht 1.5%, and the New Zealand dollar 1.0%. On the downside, the Paraguay guarani declined 1.2%, the Colombian peso 1.1%, and the Israeli shekel 0.8%. The Swiss franc and Euro both gained about 0.5%. The Canadian dollar this week traded to a 30-year high against the dollar.

Commodities Watch

For the week, Gold dipped 0.7% to $649.45, and Silver dropped 5.1% to $12.473. Copper gained 2.0%. August crude jumped $1.54 to $70.68. August gasoline was about unchanged, while August Natural Gas sank 5.7%. For the week, the CRB index gained 0.3% (up 2.8% y-t-d), and the Goldman Sachs Commodities Index (GSCI) added 0.1% (up 12.7% y-t-d).

Japan Watch:

June 26 - Market News International: "Recent currency moves are being driven by interest rate differentials and Japan should hike rates rapidly, Eisuke Sakakibara, Japan's former top currency official, known colloquially as 'Mr. Yen', said in a CNBC interview."

June 27 - Bloomberg (Ron Harui): "Bank of Japan official Tetsuya Inoue said today he anticipates massive capital outflows as Japanese households seek to diversify domestic assets. 'It's reasonable to expect that you could still see a huge amount of capital flows' leaving Japan, Inoue, deputy director-general of the central bank's financial markets department, said..."

June 26 - Bloomberg (Mayumi Otsuma and Harumi Ichikura): "Japanese corporate service prices rose at the fastest pace in more than nine years in May, backing the central bank's case that inflation will take hold in the world's second-largest economy. Corporate service prices climbed 1.4% from a year earlier..."

June 25 - UPI: "Japanese sushi chefs, faced with shortages of bluefin tuna, are experimenting with alternatives, including deer meat, horse meat and U.S.-style avocado rolls. The shortages...are being caused in part by the growing popularity of sushi worldwide, including in Russia, South Korea and China... 'It's like America running out of steak,' said Tadashi Yamagata, vice chairman of Japan's national union of sushi chefs... Japan's Fisheries Agency said the average price of imported frozen northern and Pacific bluefin has risen by more than a third, to $13 a pound, since the start of 2006."

China Watch:

June 28 - Financial Times (Richard McGregor): "China's new state investment agency is poised to secure its first significant tranche of funding with the announcement that the finance ministry will soon issue $200bn in bonds to capitalise the body... The launch of the Chinese agency coincides with an intensifying global debate about the role of sovereign investment bodies and their emerging clout in financial markets. The possibility of tie-ups between such agencies was mooted yesterday by an official of a Dubai state holding company, who said the two countries were discussing mutual investments, such as asset swaps. 'At the highest level there is already a connection. But the next step is going to be at the various business-entity levels,' Yu Lai Boon, chief investment officer at Dubai World Group..."

June 29 - Bloomberg (Josephine Lau): "China's economy may expand at the fastest pace in 12 years in 2007 and inflation will exceed the central bank's target, according to a report by economists at the People's Bank of China... Gross domestic product may grow 10.8%..."

June 27 - Bloomberg (Nipa Piboontanasawat): "China's industrial-company profits swelled 42.1% in the first five months from a year earlier, hampering government efforts to cool investment in the world's fastest-growing major economy. Combined net income increased to 902.6 billion yuan ($119bn)... Sales jumped 27.4% to 14.2 trillion yuan."

June 27 - Bloomberg (Dune Lawrence): "China's fiscal income reached 2.17 trillion yuan ($285.1 billion) for the first five months of this year, a 31% gain from the same period a year ago... The central government's fiscal revenue climbed 32% to 1.22 trillion yuan while local government income rose 29% to 951.4 billion..."

June 28 - Financial Times (Jamil Anderlini): "Ten international banks, including HSBC and Standard Chartered, have been punished by China's foreign exchange regulator for breaching strict capital controls by helping to funnel huge amounts of foreign exchange into the country's soaring stock and property markets. The banks are among a group of financial institutions revealed to the Financial Times after the State Administration of Foreign Exchange announced 29 banks - 19 of them domestic - had received unspecified punishment for 'assisting speculative foreign capital to enter the country disguised as trade or investment'... The money they helped to channel was having a 'serious effect on healthy economic development and government efforts to control growth', Deng Xianhong, Safe's deputy director, said..."

June 28 - Bloomberg (Josephine Lau): "Investments by Chinese insurers in stocks and debt soared 53% in the first five months from a year earlier, as they diversify holdings and prepare to buy more equities overseas once permitted. Such investments rose to 1.5 trillion yuan ($197 billion) through May..."

June 26 - Bloomberg (Zhao Yidi): "China completed the world's longest sea bridge, the Hangzhou Bay Sea-Crossing Bridge, in Zhejiang province... The 22.4 mile bridge links Zhengjiadai village located north of the Hangzhou Bay, and Shuiluwan village, situated south of the bay... The 11.8 billion yuan ($1.55 billion) bridge was China's first major public infrastructure project that was funded mainly by private industry..."

June 29 - Financial Times: "Ten years after the rain-drenched evening when Hong Kong passed to Chinese sovereignty, little has changed. Full democracy and cheap real estate are as elusive as ever; bars in Lan Kwai Fong as crowded; and over-subscription rates for new listings as sky-high as they ever were. The big difference, of course, is the stock market itself. In June 1997 mainland companies accounted for just 13% of the market; today they make up almost half the market capitalisation. Partly as a result of mainland issuance, Hong Kong's market cap has almost trebled to nearly US$2,000bn. Undoubtedly bigger, then. But is it better?"

June 26 - Bloomberg (Wendy Leung): "Hong Kong's export growth unexpectedly slowed last month as shipments to the U.S. fell. Overseas sales rose 12.1%..."

India Watch:

June 28 - Bloomberg (Gautam Chakravorthy): "India's central bank will lend $5 billion from its foreign exchange reserves to help build roads, ports and other infrastructure, Finance Minister Palaniappan Chidambaram said. 'We have also persuaded the Reserve Bank of India to lend $5 billion from the foreign exchange reserves,' to the India Infrastructure Finance Co., Chidambaram said..."

June 28 - Bloomberg (Debarati Roy): "Exports of jewelry from India, the world's largest producer, climbed 32% in the two months ended May... Exports reached $3.18bn..."

Asia Boom Watch:

June 25 - Bloomberg (Shamim Adam): "Asset bubbles fueled by flows of cash into Asia may signal the risk of a financial crisis, policy makers in the region say. Capital flows have inflated real estate and stock prices, according to officials including Singapore's Prime Minister Lee Hsien Loong and Thai Finance Minister Chalongphob Sussangkarn. They spoke at the World Economic Forum on East Asia conference in Singapore, 10 years after Asia's financial crisis. 'While East Asia is in a stronger position today compared to 1997, mishaps can still happen,' Singapore's Lee said... 'Recent signs of market exuberance have created fresh concerns.'"

June 26 - Bloomberg (Shamim Adam): "Singapore's industrial production in May expanded more than any economist expected, as output at pharmaceutical and transport engineering companies jumped. Manufacturing, which accounts for a quarter of the $134 billion economy, surged 17.7% from a year earlier..."

June 26 - Bloomberg (James Peng and Tim Culpan): "Taiwan's export orders rose more than expected in May, buoyed by demand from China and Europe. The island's currency pared a decline. Export orders, indicative of actual shipments in the next three months, climbed 11.9% from a year earlier..."

June 26 - Bloomberg (Denise Kee and Catherine Yang): "Asian property owners are planning to sell shares in as many as 15 real estate investment trusts within the coming year, according to Michael Smith, head of Asian real estate investment banking at Goldman Sachs Group Inc."

Unbalanced Global Economy Watch:

June 26 - Bloomberg (Gabi Thesing): "The International Monetary Fund will raise its forecast for world economic growth this year and said inflation may accelerate as a result. 'Global growth is stronger than we had expected in April,' Simon Johnson, the IMF's economic counsellor and director of research, told reporters... 'Inflationary pressures are definitely building up.'"

June 28 - Financial Times (Peter Thal): "The world's 100,000 'super-rich' last year extended their lead over the merely affluent, an authoritative study of the world's wealthy has found. Last year, the assets of those with more than $30m to invest - the so-called ultra-high net worth individuals - expanded by 16.8%. By comparison, people with assets of $1m-$5m saw their wealth grow by 6.4%. The number of ultra-high net worth individuals also swelled by more than 10%... The number of people with $1m or more to invest grew by 8% to 9.5m last year, and the wealth they control expanded to $37,200bn. About 35% is in the hands of just 95,000 people with assets of more than $30m."

June 28 - Bloomberg (Simone Meier): "Money-supply growth in the euro region unexpectedly accelerated to close to the fastest pace in 24 years in May, giving the European Central Bank room to raise interest rates further. M3 money supply, which the ECB uses as a gauge of future inflation, rose 10.7% from a year earlier, after growing 10.4% in April... 'It's surprising we haven't yet seen a slowing down in the overall rate of M3 growth,' said Nick Kounis, an economist at Fortis Bank in Amsterdam. 'Overall, we'd need to see quite a marked slowdown over the next months to change the conclusion that this is signaling upside risks to inflation and to remove the argument that further rate increases are needed.' Loans to the private sector rose 10.3% in May from a year earlier..."

June 28 - Bloomberg (Claudia Rach): "Germany's unemployment rate fell to the lowest level in 12 years in June as growth in Europe's largest economy encouraged companies to invest and hire. The jobless rate, adjusted for seasonal swings, declined to 9.1% from 9.2% last month..."

June 28 - Market News International: "Much as expected, French unemployment continued to decline in May, enough to trim the ILO jobless rate another notch to 8.1%, the lowest level in 25 years..."

June 28 - Bloomberg (Christian Wienberg): "Denmark's jobless rate fell to a new 33-year low of 3.6% in May as rising consumer demand led industries to hire more workers, fueling concern the economy may overheat."

June 29 - Bloomberg (Jonas Bergman): "Swedish household debt growth accelerated in May as employment and wages rise in the largest Nordic economy. Household borrowing increased an annual 11.9% in May..."

June 28 - Bloomberg (Robin Wigglesworth and Beate Evensen): "Norway's jobless rate was unchanged in the three months through May... The...unemployment rate remained at 2.7%, the lowest since at least 1989..."

June 26 - Bloomberg (Mark Sweetman): "Russia's central bank doubled its forecast for net capital inflow this year to $70 billion, Interfax reported."

Latin American Boom Watch:

June 25 - Bloomberg (Telma Marotto and Katia Cortes): "Brazilian bank lending rose 2.4% in April from a month earlier as lower interest rates spurred companies to boost production and consumers to purchase more goods...Bank lending rose 21.9% from April 2006."

Central Banker Watch:

June 24 - Bloomberg (John Fraher): "The credibility of central banks around the world may hinge on their response to surging money and credit growth, which is helping fuel asset bubbles, the Bank for International Settlements said. 'The current rapid expansion of these aggregates in various parts of the world may lead some central banks to ask soul-searching questions about the appropriate policy response,' the BIS said... 'Ultimately, the credibility of central banks lies in the balance.'"

Bubble Economy Watch:

June 26 - Market News International (John Shaw): "Congressional Budget Office director Peter Orszag told the House Budget Committee...that foreign holdings of U.S. Treasury debt 'have grown rapidly in recent years' and now exceed $2 trillion, accounting for more than 40% of Treasury debt held by the public. ...Orszag said that foreign holdings of U.S. debt rose almost 50% between 2003 and 2006."

June 26 - Bloomberg (Elizabeth Hester): "Former U.S. Vice President Dan Quayle and K2 Inc. Chief Executive Officer Richard Heckmann filed to raise as much as $500 million in the second-largest initial public offering of a 'blank check' shell company. Heckmann Corp....plans to sell 62.5 million units for $8 each... The offering is for a blank-check company, also known as a special-purpose acquisition company, or SPAC. Blank-check companies have raised $4.1 billion in 33 IPOs this year, compared with $1.4 billion in 22 offerings during the same period a year ago..."

June 29 - EconoPlay,com (Gary Rosenberger): "Hiring was slower than expected in June as employers were handcuffed by a host of economic challenges led by the housing slump, the subprime blowout, and high gas prices - thwarting optimistic expectations for the second half of 2007, recruiters say. The slowdown cut across a wide swath of skills and professions, with the normal summer ramp-up in logistics and retail deemed particularly disappointing. Professional areas like information technology or finance and accounting were also slowed for a variety of reasons, including a paucity of ideal candidates..."

June 26 - The Wall Street Journal (Julie Jargon): "For the second time this year, Jim Oberweis is raising the price of milk his family-owned company delivers to 35,000 homes in the Midwest and sells at its 44 dairy shops... The recent rise in milk prices is affecting everyone from small dairy companies like Oberweis to the nation's largest milk producers and food companies. On Friday, the Agriculture Department, which regulates the minimum milk prices received by farmers, set the price that processors will have to pay for drinkable milk in July at $20.91 per hundred pounds of milk, up 17% from the June price and up 84% from a year earlier."

Financial Sphere Bubble Watch:

June 29 - Financial Times (Saskia Scholtes): "Rising credit market volatility has triggered concern at investment banks that they may be forced to honour commitments to provide billions of dollars of financing for private equity buy-outs that may now be difficult to place with investors. In the coming months, bankers have close to $250bn of new bonds and loans slated for issue in the US alone, much of it related to leveraged buy-outs and other merger activity. If they cannot sell on the debt on terms originally planned because markets have changed, they may be forced to hold billions of dollars of high-yield debt."

June 29 - Dow Jones (Natasha Brereton ): "The global financial system may have become more vulnerable to potentially large financial crises, a senior Bank of England official said... While financial innovation has allowed better management and wider dispersal of risks, the greater integration of capital markets means that were a major problem to occur, it would be more likely to spread quickly across borders, Executive Director for Financial Stability Nigel Jenkinson said... 'The flip side to increased resilience of the financial system to small and medium-sized shocks may be a greater vulnerability to less frequent but potentially larger financial crises,' Jenkinson said."

Mortgage Finance Bubble Watch:

June 27 - The Wall Street Journal (Michael Hudson): "Twelve years ago, Lehman Brothers...sent a vice president to California to check out First Alliance Mortgage Co. Lehman was thinking about tapping into First Alliance's lucrative business of making 'subprime' home loans to consumers with sketchy credit. The vice president, Eric Hibbert, wrote a memo describing First Alliance as a financial 'sweat shop' specializing in 'high pressure sales for people who are in a weak state.' At First Alliance, he said, employees leave their 'ethics at the door.' The big Wall Street investment bank decided First Alliance wasn't breaking any laws. Lehman went on to lend the mortgage company roughly $500 million and helped sell more than $700 million in bonds backed by First Alliance customers' loans... Today, Lehman is a prime example of how Wall Street's money and expertise have helped transform subprime lending into a major force in the U.S. financial markets. Lehman says it is proud of its role in helping provide credit to consumers who might otherwise have been unable to buy a home, and proud of the controls it has brought to a sometimes-unruly business."

Foreclosure Watch:

June 26 - Bloomberg (Jody Shenn): "Delinquencies and defaults on U.S. subprime mortgages made last year rose in May, cementing their record of being the worst-performing in their category ever... Late payments, foreclosures and already seized property among bonds from the second half of last year used for 'ABX' credit derivatives rose 2.15 percentage points to 14.51%... That's the biggest increase this year..."

MBS/ABS/CDO/Derivatives Watch:

June 29 - Bloomberg (Shannon D. Harrington): "U.S. bank revenue from trading derivatives and other contracts jumped 24% to a record $7 billion in the first quarter as low yields from bond markets prompted more investors to turn to derivatives that can boost returns... Trading in derivatives contracts by banks including JPMorgan Chase & Co. and Citigroup Inc. rose 10% to cover a record $145 trillion in securities, up 31% from last year's first quarter, the U.S. Office of the Comptroller of the Currency said... 'Because investors have faced very tight credit spreads and a flat-to-inverted yield curve for some time now, they have increasingly turned to more complicated and highly structured products,' Kathryn Dick, the agency's deputy comptroller for credit and market risk, said... Trading in credit derivatives, the fastest growing part of the derivatives market, surged 86% to cover $10.2 trillion in debt securities."

June 29 - Dow Jones: "The OCC...said federally insured U.S. commercial banks earned a record $7.0 billion in trading revenues in the first quarter, up 24% from the same quarter last year."

June 26 - The Wall Street Journal (Serena Ng and Henny Sender: "The corporate buyout boom of the 1980s was funded in large part by high-yield 'junk' bonds. This time around, another financial product is supplying much of the fuel -- collateralized loan obligations. CLOs...are giant pools of bank loans bundled together by Wall Street and sold off to investors in slices. They aim to spread default risk an inch deep and a mile wide. Last year, more than half of the loans behind the record wave of buyouts were parceled out to investors as CLOs, bankers say. As corporate borrowing soars, however, concerns are growing that CLOs have made it too easy for shaky or debt-laden companies to borrow money."

June 28 - Financial Times (Saskia Scholtes and Gillian Tett): "As head of the financial stability unit at the Banque de France, Imène Rahmouni-Rousseau traveled to America this month to look at the current turmoil in the US subprime mortgage world. Although initially that had seemed an all-American saga, Ms Rahmouni suspected that French and other European investors also held assets linked to subprime securities. So on behalf of her central bank she wanted to assess the risks. What she discovered surprised her. There was little confidence about how to value the holdings. 'Pricing data are difficult to obtain,' she says. It is a discovery being shared by numerous other policymakers and investors around the world as the fallout widens from a subprime lending boom... unlike stocks listed on an exchange or US Treasury bonds, CDOs are rarely traded. Indeed, a distinct irony of the 21st-century financial world is that, while many bankers hail them as the epitome of modern capitalism, many of these new-fangled instruments have never been priced through market trading. Instead, products such as CDOs, which are designed to be held until they mature, have often been valued in investor portfolios or on the books of investment banks according to complex mathematical models and other non-market techniques."

June 26 - Bloomberg (Darrell Hassler): "Fitch Ratings and Standard & Poor's today warned investors that subprime-mortgage securities similar to those responsible for the near collapse of hedge funds run by Bear Stearns Cos. are deteriorating quickly. Fitch said it may cut ratings on four collateralized debt obligations valued at about $3.1 billion that are linked to some second-lien subprime loans. S&P downgraded 45 bonds backed by subprime mortgages and said it may reduce ratings on 88 more, following similar action by Moody's...last week."

Real Estate Bubbles Watch:

June 25 - California Association of Realtors (CAR): "Home sales decreased 25% in May in California compared with the same period a year ago, while the median price of an existing home increased 4.8 percent... The median price of an existing, single-family detached home in California during May 2007 was $591,180, a 4.8% increase over the revised $563,860 median for May 2006... 'The decline in sales continues to be driven by both tighter underwriting standards since the start of the year and the adverse psychological impact of news regarding foreclosures and the subprime situation,' said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. 'In particular, the lower end of the market...has seen greater declines in sales and weaker prices than the higher end of the market..." Highlights of C.A.R.'s resale housing figures for May 2007: . C.A.R.'s Unsold Inventory Index for existing, single-family detached homes in May 2007 was 10.7 months, compared with 6 months for the same period a year ago."

June 26 - Bloomberg (Courtney Schlisserman and Joe Richter): "Home values in 20 U.S. cities fell the most in at least six years as higher mortgage rates and a record supply of properties for sale deepen the housing slump. The S&P/Case-Shiller index of 20 metropolitan areas declined 2.1% in April from the same month a year earlier, led by Detroit and Miami..."

Fiscal Watch:

June 28 - Bloomberg (Stacie Servetah and Terrence Dopp): "New Jersey Governor Jon Corzine today signed a $33.5 billion state budget for fiscal 2008... The signed budget is $2.4 billion, or nearly 8% above last year's plan..."

Speculator Watch:

June 26 - Bloomberg (Jody Shenn and Bradley Keoun): "Bear Stearns Cos. is getting a taste of its own medicine. It was Bear Stearns, the biggest broker to hedge funds, that nine years ago declined to join 14 other investment banks in the bailout of Long-Term Capital Management LP. Then last week, as...Bear Stearns pleaded for help to rescue two of its hedge funds teetering on the brink of collapse, many of the same firms refused to come to its aid."

June 26 - Bloomberg (Matthew Leising): "Amaranth Advisors LLC held natural gas trades worth more than $18 billion and exploited loopholes to evade regulators who tried to limit the firm's speculation on its way to becoming the biggest-ever hedge fund collapse, a Senate investigation found."

First-Half Global Liquidity Watch:

June 29 - Reuters (Natalie Harrison) - "The credit market has had a strong run so far this year, with global corporate bond issuance, for both high-yield and investment grade, up around 30% in the first half from the same period a year ago. Overall, global debt capital market deals are up 11% in the first half of 2007, compared with the first six months of last year, totalling $3.7 trillion, according to...Dealogic... Of the $1.26 trillion global investment-grade deals done since January, $626 billion were in the European, Middle East and Africa (EMEA) region, and $502 billion in the Americas. The latter was a 36% increase on the period from January to end-June 2006. In terms of size, Asia Pacific and Japan trailed behind, but still saw a 26% and 42% respective jump in deals. The Americas accounted for the vast majority of high-yield deals too, with a 40% jump in the value of issuance to $109 billion, followed by EMEA, where deal values rose to $48 billion... Global asset and mortgage-backed securities were also dominated by the Americas, which generated $1 trillion of them, though that was down 4% from the first half of 2006. EMEA saw the strongest pick-up, with a 39% rise in issuance to almost $311 billion."

June 29 - Financial Times (Anuj Gangahar and Joanna Chung): "Riskier types of debt accounted for a higher portion of global corporate fundraising in the first half of this year than last, underlining investors' robust appetite for low-quality paper. Leveraged loans, highly leveraged loans and high-yield bonds made up 29% of the total global corporate fundraising, up from 22% during the same period last year, according to Dealogic. The amount of cash raised through the debt capital markets as a whole - including bonds of both investment grade and lower-quality junk-rated paper - reached $1,450bn, the highest volume on record, and up 32% over the same period last year."

June 29 - Financial Times (Lina Saigol): "The volume of merger and acquisition activity worldwide surged 50% to reach $2,780bn during the first six months of the year, despite growing concerns among companies about a turn in the credit markets and fears that the cycle has reached its peak. Since 2003, chief executives and private equity investors have been fuelling the M&A boom by taking advantage of cheap debt and strong cash flows to bid for companies... Buy-outs by private equity groups reached a record high of $568.7bn, a rise of 23% on the previous high of $459.2bn in the second half of 2006... Private equity represented 20% of total announced M&A this year, according to Dealogic... Europe, the Middle East and Africa accounted for 44% of global volume during the first six months of the year to reach $1,230bn. In the US, the volume of deals increased by 37% over the same period, while the pace of activity in the Asia-Pacific region reached $353.4bn. In emerging markets, volume rose 17% to $356bn, with Russia the most targeted nation, followed by China and India."

June 29 - Reuters (Jessica Hall): "Merger activity in the United States hit a new record in the first half of the year, fueled by deep-pocketed private equity firms and low borrowing costs, even as the pace of deals began to slow in June... The U.S. broke through the $1 trillion level for total mergers, marking the first time that mergers have hit that level in the first six months of any year, according to...Dealogic. So far this year, U.S. merger volume totaled $1.005 trillion, up 36% from the same period a year ago. The number of deals, however, dropped 12%... April was the busiest month of the year in the U.S., with $210.5 billion in deals, while June was the slowest month with $124.2 billion in deals, Dealogic said."

June 29 - The Wall Street Journal (Ellen Sheng): "Chinese and Indian companies raised the most money from the stock market during the first half, according to a ranking of Asian countries excluding Japan, Australia and New Zealand, from...Dealogic... Fueled by the booming economy, the number of Chinese initial public offerings nearly doubled in the January-June period from a year ago and helped push the number of stock deals in Asia, excluding Japan, up 55% from year-earlier levels. In all of Asia, there were 838 deals raising $99.5 billion in the first half, compared with 723 deals, which raised $64.1 billion, last year. Chinese companies launched 85 IPOs, raising $21.5 billion in total, up from 46 IPOs raising $15.6 billion a year ago. Including secondary offerings and convertible deals, mainland Chinese companies did 177 deals and raised $47.1 billion in the year to date, up from 100 deals and $25 billion a year ago."

June 29 - Reuters (Brian Kelleher): "Asia Pacific mergers and acquisitions excluding Japan surged 50% in the first half to a record $253 billion, with Australian buyout deals and an overseas push by Indian firms expected to keep activity at high levels. Australia accounted for $76 billion worth of deals in the half, followed by China ($55 billion) and India ($39 billion), according to...Dealogic."

June 29 - Reuters (Brian Kelleher) - Privately owned Chinese companies helped drive a 42% increase in Asia Pacific stock issuance in the first half, and a recent wave of Indian activity will keep bankers busy through the rest of 2007. Asia Pacific equity capital markets volume, excluding Japan, was $105.1 billion in the first half, according to...Dealogic, and bankers expect the strong activity to continue through the second half."

June 29 - Reuters (Daisy Ku): "More listings from Russia and the Middle East are expected to keep markets buoyant after Europe set the global pace for IPOs in the first half with a 51% gain and topped the United States in total issuance. Equity capital markets activity reached $445 billion over the first six months of 2007 on 3,000 deals, the highest dollar volume since the record set in 2000, according to...Dealogic. It was a 19% gain from $375 billion in the first half of 2006."

Runaway global Credit and liquidity excesses fuelled major global equities indexes to solid - and in some cases spectacular - first-half gains. The German DAX surged 21.4%, France's CAC40 9.3%, Britain's FTSE 6.2%, Amsterdam's Exchanges index 10.7%, Stockholm's OMX index 9.4%, and the Swiss Market Index 4.8%. The Nikkei rose 5.3% and Hong Kong's Hang Seng jumped 9.1%. Here at home, the Dow Jones Industrials gained 7.6%, the S&P500 6.0%, the S&P400 Mid-Cap index 11.3%, the Russell 2000 5.8%, and the NASDAQ100 10.1%.

The emerging markets boom hardly missed a beat throughout the first half. China's Shanghai Composite index jumped 42.8%, South Korea's Kospi 21.6%, Taiwan's Taiex index 13.5%, Brazil Bovespa 22%, Mexico's Bolsa 17%, and Chile's Stock Market Select index 29%. Winners in European emerging equities indices included the Prague's major index up 17.0%, Budapest up 16.4%, Poland's WIG20 14.4%, and Istanbul's XU100 index 20.4%. Most markets in the Middle East and Africa also posted strong gains. Global (non-U.S.) real estate and art inflation were in full force.

As for global securities issuance and M&A - the fuel for the equities Bubble - the first half was one for the record book. Record total global debt market issuance of $3.7 TN was up 11% from comparable 2006. Leveraged loans and junk bonds rose to almost a third of total corporate issuance. Announced global M&A jumped 50% to $2.78 TN. It was certainly a case of global financial players working overtime to reap once-in-a-lifetime bounties, in the process ensuring future financial crisis.

The liquidity theme for most of the first half was one of unprecedented global M&A activity financed by increasingly complex and risky debt structures, all made possible with even more astounding financial sector leveraging. Looking back, February's subprime implosion provided only a brief setback (respite) for a desperately overheated global Credit and speculation infrastructure. The global M&A and securities leveraging booms had already attained critical mass, while Wall Street and the leveraged speculating community had achieved a full head of steam.

Yet late June's hedge fund and CDO problems appear more all-encompassing and ominous. February was about U.S. subprime mortgages, while the issue gravitated toward the heart of "contemporary finance" as the second quarter winded down. To be sure, the story of the historic first half ends with serious questions regarding the sustainability of Global Credit Bubble excess. It has "inflection point" written all over it.

"Repo Agreements," as reported by the New York Fed, ballooned $455bn during the first half (28% annualized) to $3.904 TN. Inflating Wall Street balance sheets have directly and, by financing clients, indirectly played a major role in financing the M&A boom. To what degree the leveraged strategies we've seen turn problematic in subprime have been used to lever up corporate Credits will be a crucial issue going forward. Importantly, the CDO marketplace now under the microscope and will likely be so for some time to come.

The Financial Times Saskia Scholtes penned an excellent article in yesterday's edition, titled "Does it all add up?"

"These elaborately constructed securities, called collateralised debt obligations (CDOs), are designed to yield juicy returns while also carrying high credit ratings. They have proved popular with hedge funds as well as with longer-term investors such as pension funds and insurance companies, many of which have bought billions of dollars of such securities in recent years - thus providing the liquidity that was then channelled into mortgage loans. But heavy losses incurred at the two Bear Stearns hedge funds as a result of such financial haute couture have prompted fears that the CDO emperor may turn out to have no clothes. Such a revelation could threaten the value of investor portfolios around the globe - not just in the mortgage sector but in the way many sorts of company fund themselves. This is because unlike stocks listed on an exchange or US Treasury bonds, CDOs are rarely traded. Indeed, a distinct irony of the 21st-century financial world is that, while many bankers hail them as the epitome of modern capitalism, many of these new-fangled instruments have never been priced through market trading."

It is rather ironic that this "golden age of Capitalism" has increasingly been financed by obscure "marketable" Credit instruments and derivatives that only rarely trade in the marketplace. Moreover, in a marketable securities-based Credit system where gains on securities holdings play such a prominent role, there has been a major shift to instruments, structures and strategies specifically to avoid "marking" to actual market prices when those prices are in decline. Or, from another angle, the CDO market represents some of the potentially weakest debt structures imaginable: lend in gross excess to extremely weak Credits; bundle them in esoteric structures; have these structures be illiquid and difficult to price; sell them for the purpose of speculation/"Credit arbitrage"; and then have highly leveraged securities firms financing the speculators enormous leverage.

It is not by happenstance that risk intermediation practices have turned increasingly to gimmicks, obfuscation and worse. By their very nature, Credit booms demand progressively more challenging risk "intermediation". The current Global Credit Bubble requires the transformation of unprecedented amounts of risk into "top-rated" securities - in keeping with the highly leveraged portfolios where much of today's risk is domiciled. Over the past couple of years, the now arduous intermediation process forced all the major players to push the envelope - the investment bankers, the rating agencies, the leveraged speculators, and the regulators/policymakers.

It was really not that difficult back in February for the bulls to proclaim that mortgage problems were isolated to subprime. This will simply no longer suffice, not now that attention has been focused on CDOs, liquidity, pricing, leveraging and unrecognized risks. Is subprime risk in CDOs the proverbial "tip of the iceberg?" Of course it is. The central issues of problematic liquidity dynamics, fair and accurate pricing, and speculative leveraging excesses today permeate the entire global Credit system.

To be sure, the CDO market is the tip of a derivatives iceberg when it comes to risk obfuscation and market pricing issues. Arcane instruments, lack of transparency, and tainted markets can (and did) remain non-issues for quite some time. Yet the longer the period of chicanery the more abruptly greed will inevitably succumb to fear. Today, markets are turning fearful. It is fearful of the quality of assets supporting the massive securitization marketplace. It is fearful of mispricing. It is fearful of liquidity. And, importantly, it is fearful of the ramifications of - in today's overheated financial environment - any meaningful movement away from risk assets. All the fears are justified.

Subprime imploded specifically because of "Ponzi Finance" dynamics. As long as Credit was readily available, individuals could borrow and/or refinance to a more accommodating mortgage. But the day the music stops is the day Credit losses begin to explode. And when it comes to Credit booms, subprime was no anomaly. The perpetuation of the subprime boom was the (only) means for an overheated Credit system to finance the marginal borrower - in order to sustain the housing/mortgage finance Bubbles. Enormous festering risks were well-concealed by the illusion of perpetually rising asset prices and limitless market liquidity.

I won't attempt to make the case that the global M&A Bubble is (quite) as acutely vulnerable to "Ponzi" dynamics as subprime. But we do know that a proliferation of deals has created a current pipeline of hundreds of billions of risky corporate loans that will need to be sold into an increasingly risk-challenged marketplace. Additionally, the M&A boom has been instrumental in inflating global equities markets, both by bidding up prices and fostering general liquidity and speculative excess. A reversal of these dynamics is now a distinct possibility. A serious market liquidity problem will commence with any move by the leveraged speculators to aggressively hedge risk and/or place bearish bets.

In "Ponzi" fashion, problems getting debt sold would pierce a susceptible M&A Bubble, likely initiating a powerfully recursive cycle of declining equity prices, speculator angst, further debt market stress and the specter of deleveraging. This is an inherent predicament of Credit and leveraged speculation-induced asset Bubbles. And while the corporate debt Bubble may not be "subprime," there are certainly scores of less than prime borrowers, dangerous speculative dynamics, and latent Credit losses vulnerable to any tightening of the Credit and liquidity landscape.

Returning briefly to the "distinct irony of the 21st-century financial world...and the epitome of modern capitalism," I can comfortably state that Capitalism has never generated such a seductively contemptible boom, one financed by a Credit system so captivatingly free-market challenged. Global central bank reserves will soon surpass $5.5 TN. Fannie and Freddie's combined "books of business" today exceed $4.1 TN. Untold Trillions of leveraged securities holdings have evolved specifically because the Federal Reserve (and global central bankers) "pegs" short-term interest rates, promises advanced warning of any rate increases, and basically guarantees that markets will remain liquid. Too many guarantees and promises are to blame for securitization and derivatives markets thoroughly perverting global risk markets.

How anyone really could have expected such a system to effectively regulate Credit, price risk, and allocate resources is beyond me. Subprime CDOs - yes, the tip of the iceberg. And today's surging oil prices, widening Credit spreads and weak dollar wouldn't appear to portend bullishness. It's official, we're now on Second-Half Liquidity Problem Watch.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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